November 10, 2010 mortgage rates outlook

MBS prices are down on the session (FNMA 3.50 -11/32), in volatile trade. The stock market is down as well (Dow -45.07, S&P -3.39). Weekly Initial Jobless Claims came in better than expected (435k vs. 450k est.), as did the Trade Balance ($-44.0B vs. -$44.8B est.). Import Prices were in-line with the previous reading, but Export Prices were up a bit. The data did not hit MBS prices immediately, but may be contributing to the current sell-off. That said, inflation fears are likely behind most of the recent increase in rates. While most foreign countries approved of the US Fed's initial round of quantitative easing, the recent announcement of the 2nd round of QE (aka QEII) has elicited criticism from around the globe. In 2009, fears were of deflation and rampant unemployment, but fears seem to be turning to inflation. Many investors are of the opinion that QE has a lagging impact, so we are yet to see the full effect of QEI, and that we should be fearful that further easing may stoke the flames of inflation. There are clearly opinions on both sides of this argument, but only time will tell the true impact of these unprecedented moves by the Fed. Throughout all of this, keep in mind that the Fed has a dual mandate, meaning that they are tasked with ensuring two things: 1) maximum US Employment, and 2) price stability. The Fed will employ all sorts of measures to accomplish these goals, lowering/raising rates and quantitative easing are two major measures for spurring business investment, and thus theoretically creating jobs. Manipulating rates via the Fed Funds rate had always been a strong lever used by the Fed, but as we know, the Fed Funds rate has been set near zero since the recession took hold, so QE has become their method of keeping rates low. Critics of QE argue that by purchasing government bonds, the Fed is basically printing money out of nothing. This practice, on its face, may lead to inflation, as more dollars exist in the market, for which there may be diminishing demand. These same critics believe that eventually, buyers of dollars and dollar denominated assets (stocks bonds) may dump these assets as they become wary of US-led inflation. This flight away from dollar assets would send rates higher. The Fed would then need to raise rates to address the mandate of price stability. This is likely the fear behind allot of the recent negative bond market moves.



Tomorrow, Thursday, 11/11 is Veteran's Day. No economic data will be released, and the bond markets will be closed. Just a reminder, WJB (including the lock desk) is open for normal business hours tomorrow.